John Maynard Keynes: applying his model for economic growth to Britain today would be relatively simple. Photograph: Topical Press/taken from picture library

It's probably just as well for George Osborne that budget speeches rarely linger long in the memory, because this time last year the chancellor was boasting about how his package of measures would put "fuel in the tank of the economy". Fuel laced with sugar, it transpires. Unlike in the US, where there are clear signs of economic recovery, Britain has gone sideways since the spring of 2011 and there is no great confidence in the Treasury or the Bank of England that it will do much better in 2012.

For Labour, the lesson from what has been happening on the other side of the Atlantic could not be plainer. Over there, Barack Obama has resisted pressure from Tea Party Republicans to slash the budget deficit and has been rewarded for his bravery. Over here, the government – in the words of the oft-repeated opposition mantra – has cut too far too fast and strangled the recovery at birth.

To simplify, Osborne's critics say that Keynesian economics is alive and well on the other side of the pond but has run smack up against Treasury orthodoxy in the UK, with the same baleful consequences as in the 1920s and early 1930s. Labour has great fun twitting Liberal Democrats about how their connivance in attempts to balance the budget is a repudiation of everything their great hero stood for.

The core Keynesian case, as explained in the general theory, goes something like this. Aggregate spending in the economy is made up of two big elements – consumption, which is driven by income, and investment, which depends on the "animal spirits" of entrepreneurs. As some of Keynes's critics have noted, there was no place in it for overseas trade. Keynes said that the key relationship was between investment and national income; the economy would expand and unemployment would fall if businesses were persuaded that it was a time to spend more on plant, machinery and innovation.

In normal circumstances, policy makers could achieve this end by tinkering with the cost of borrowing, because when interest rates were low there was less incentive for businesses to hold on to their cash. There were, however, times when firms would be determined to hoard their money no matter how low interest rates were driven. The solution then was what Keynes called "a somewhat comprehensive socialisation of investment": the state stepping in to do the spending not forthcoming from the private sector because the animal spirits of entrepreneurs were low.

Applying this model to the Britain of today is relatively simple. Weak real income growth and the desire to rebuild savings means that consumption growth cannot drive economic recovery, while the reluctance of banks to lend coupled with low animal spirits means private investment is not responding to ultra-loose monetary policy. Aggregate spending, therefore, can only be maintained through fiscal policy. Moreover, if the government seeks to cut budget deficits at this time it risks a Japan-style "lost decade".

It does, indeed, seem likely that Keynes would be critical of Osborne's austerity plan (and even more disturbed at the self-flagellatory fiscal policy in the eurozone). He would have been particularly unimpressed by the bogus argument that if the private sector is paying off its debts then the public sector should be belt-tightening as well. Keynes, the founder of modern macro-economics, would have argued that this was the sort of balanced-budget strategy tried when tax receipts plummeted in the wake of the Wall Street Crash; the consequence was an even lower level of aggregate demand and a deeper slump. Keynes's advice to Osborne would be: look after employment and the deficit will look after itself.

The chancellor's retort would be that he is trying to boost employment, but relying on monetary policy rather than fiscal policy to do the job. Osborne calls himself a budgetary conservative and a monetary activist, by which he means that tackling the budget deficit provides the space for the Bank of England to keep interest rates low, both directly through bank rate and indirectly through quantitative easing. Spending a bit more or announcing unfunded tax breaks would, the chancellor argues, risk alarming the financial markets, which set the interest rates on government bonds through their daily activities. Higher interest rates on bonds feed through into dearer mortgages and overdrafts.

Osborne's Keynesian critics need to take this argument seriously, not least because Keynes himself was a strong advocate of monetary policy and saw the socialising of investment only as a last resort. This is a point well made by the monetarist economist Tim Congdon, who argues in his book of essays (Money in a Free Society: Encounter Books) that Keynes himself was not entirely convinced there was ever a point when monetary policy became ineffective – the so-called liquidity trap. Keynes, according to Congdon, was actually a monetarist before it became fashionable. This might be pushing it a bit, but it is worth noting that Keynes was something of an inflation hawk, thought budgets should be in surplus in the good times to balance the deficits in the bad times, and policy makers should pull all the available monetary levers first.

There are, therefore, economists who believe that the real lesson from the US is that central banks need to adopt aggressive and – if needs be – unorthodox monetary policy to fight deep-seated recessionary forces. Graham Turner, of the consultancy GFC Economics has nothing but praise for the Federal Reserve's Operation Twist, intervention in the market for Treasury bills designed to cut borrowing costs by reducing interest rates on long-date bonds. Writing in the March 2012 Economic Journal, Roger Farmer of UCLA says the correct Keynesian response today is for government share buying programmes rather than fiscal expansion.

All of which takes us back to Wednesday and the contents of Osborne's red box. The risk is of the UK getting stuck in low growth, high unemployment equilibrium, with an over-restrictive fiscal policy making it harder for monetary policy (interest rates, QE and the exchange rate) to gain real traction in an economy still suffering the after-effects of a severe financial shock.

As such, Osborne's priorities should be to keep monetary policy loose, to engender confidence, to provide a modest fiscal boost and to ensure that any budget giveaways go to those with the highest propensity to spend rather than save. That, in case you are wondering, means the poor, not the rich.